"Our outlook for the country's banking system remains negative, as it has been since November 2011.

"The negative outlook reflects our view that high leverage in the corporate sector could prevent any meaningful recovery in asset quality, notwithstanding a moderate rebound in economic growth," the agency Moody's Investors Service said in a note issued from Singapore.

The report further said continuing poor asset quality, wherein the NPAs levels are set to touch 4.5 percent of the system, will require continued provisioning and strengthened capital buffers. After provisions, profitability of public sector banks will generate insufficient internal capital for
loan growth, the report added.

The negative outlook pertains mainly to the public sector banks as they represent more than 70 percent of total banking system assets. These banks have experienced higher growth rates in non-performing and restructured loans, as well as greater weakening in profits, than their private sector peers, Moody's said.

The report says while these trends are unlikely to improve for public sector banks, in contrast, private sector banks have stronger margins, reserves, and capital levels, which serve as buffers against conditions that remain challenging.

On growth, which inched up to  surprising 5.7 percent in the first quarter of the current fiscal after logging in sub-5 percent growth in the past two fiscals, Moody's said GDP will pick up moderately this fiscal, but remains constrained by the high interest rates due to inflation.

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